Great Reasons To Rent
By Mike Hammer
Published: May 4, 2008
Before the housing boom went bust this year, homeownership was considered a good investment. But now, with the rash of mortgage foreclosures, renting may be a more attractive option. Here’s why.
Renting can save money.
According to popular myth, renters are just throwing their money away. But the reality is that when you buy a home, you’re paying for closing fees, mortgage interest, property taxes, private homeowners’ insurance and maintenance—costs that return nothing on your investment. You’d be better off banking that money or putting it into the stock market. In fact, a recent study by Fidelity Investments indicates that stocks provided investors with nearly 4.6% higher average returns in the last 45 years than real estate.
Homeowners’ tax deductions are overstated. Conventional wisdom says that buying a home saves you money because the mortgage interest is tax-deductible. But a study by the National Multi Housing Council points out that half of home¬owners don’t get a break, because even with mortgage interest and property taxes, their total deductions do not exceed the standard federal tax deduction ($10,900 for couples and $5450 for singles).
There are more options available to renters. With fewer houses and condos selling, more owners are converting their properties into rentals or providing incentives to lure prospective tenants. In condo-heavy cities such as Palm Beach, Fla., for example—where the vacancy rate has jumped 2.5%—investors are undercutting apartment rates to generate interest. “A lot of people are offering three free months to attract renters,” says Robert Smith, a real-estate adviser in Orlando, Fla. “And modern apartments offer amenities that may be unaffordable in a new home.”
Renting gives you flexibility. Buying a home is a big commitment. If you have to move for any reason—say, for work—your property would need to appreciate by at least 10% for you to recover your sales costs, which typically takes about five years. Renting allows you the freedom and mobility you need to find the right job before you tie yourself to a massive home investment.
Don't Buy the Myths: Renting Can Be a Smart Decision
Rent vs. Buy
“You need to buy a house." How many times have you heard that? Turns out that could be bad advice. Here's why:
Every year, thousands of Americans jump into homeownership for the wrong reason, usually pressure from friends or family. It turns out a lot of them could actually save money by renting.
As the Wall Street Journal wrote in a 2001 article, “Contrary to popular opinion, renting can often be the better alternative, especially if there's a chance you'll stay put less than five years."
This brochure is designed to help you make an educated decision about your housing choice. There are many good reasons to buy a house, but most of them are not financial. The investment potential and the tax savings associated with homeownership are often overstated, while the costs of homeownership are frequently understated.
Instead of feeling pressured to buy, you should choose the housing that best suits your lifestyle. If you value convenience, amenities, flexibility and superior locations, you probably ought to rent. This brochure explains why you can do so with the knowledge that you are not “throwing your money away."
The fastest growing segment of the apartment market is households earning $50,000 or more. What do they know that you don't?
MYTH# 1: I'll reduce my tax bill if I buy a house.
Reality: A majority of owners reap no annual tax benefits from owning a house.
The biggest homeownership myth in the country is that owning a house is a huge tax break. If your mortgage interest and other qualifying expenses aren't more than the standard deduction ($9,500 for joint filers, $4,750 for singles in 2003), there is no tax advantage to owning. That's one reason why only 34% of all taxpayers itemize.
Even if you are able to deduct your mortgage interest and property taxes, remember that depending on your tax bracket, you are still only saving no more than 10 cents to 35 cents in taxes for every dollar you pay in mortgage interest.
Assume you buy a $200,000 house with a 5% down payment at a 6% interest rate. Your total net tax savings, assuming you are in the 28% tax bracket, is a mere $514. That's right. You will be able to deduct $11,336 in mortgage interest, but you would have gotten a $9,500 standard deduction without buying.
So your tax savings are $11,336 minus $9,500 times 28% tax rate, which equals $514. Once you factor in your maintenance and repair expenses, your tax savings could quickly disappear. Maintenance costs often run between 1% and 2% of your house's value annually, depending on the house's age (See Myth# 3).
Assuming a conservative 1% maintenance cost, you may have to spend $2,000 to save $514 in taxes.
Don't Buy the Myths
Once you factor in the standard deduction and maintenance costs, you could end up spending thousands just to save a few hundred dollars in taxes.
MYTH# 2: Paying rent is throwing away money. I could be building equity.
Reality: For the first five years of ownership, you are simply giving away money to the bank.
During the first five years, more than 80% of your monthly mortgage payment is interest. And nearly one third of all homeowners move within five years, before they start building any real equity.
Add in the money they spent during that time on maintenance, taxes, insurance and the costs to buy and sell their house, and most would have saved money by renting.
Assume you buy a $200,000 house with a 5% down payment at a 6% interest rate. After five years of mortgage payments, you will have paid $55,152 in interest and only $13,196 in principal. In addition, you will likely have paid between $10,000 and $20,000 in maintenance and repair (see Myth# 3) to earn that equity.
Chances are you could earn more than this in a number of investments that are more diversified and less risky than putting all of your eggs in one basket
MYTH# 3: My mortgage payment will be less than my rent.
Reality: Your mortgage payment is just the beginning. The “hidden costs" of ownership can add up to thousands of dollars a year.
Few prospective owners truly appreciate how expensive annual maintenance on a house can be. A Wall Street Journal commissioned study concluded that “almost every house, no matter how recently or expertly built, is a money pit. "
On average, you should expect to spend 1% to 2% of your house's value annually on maintenance. For a $200,000 house, that means $2,000 to $4,000 a year for maintenance.
And that doesn't include property taxes, homeowner's insurance or any home improvement, decorating or landscaping you decide to do. Owning also requires a different kind of budgeting discipline. You need to be prepared for the unexpected, like the furnace that needs to be replaced, the roof that needs to be fixed or the leaking basement. Renters, on the other hand, have the convenience of knowing exactly how much their housing is going to cost them each month.
Writing of her experiences as a new homeowner, one columnist said, “Taking care of your humble abode can be so time-consuming that the American dream can turn into a nightmare." “I've been a homeowner for only six months, and already I've spent thousands of dollars beyond my closing costs and down payment…but most of the expenses, unfortunately, I won't ever recoup."
By “renting…we quickly achieved more space, better appliances, better fixtures, better everything…I estimate that by renting, instead of owning, we have more than doubled the value of dollars we spend on housing."
The New York Times
MYTH# 4: As an owner, my housing costs will stay constant. I won't have to worry about rent increases.
Reality: Only your mortgage payment will remain constant. Other costs can go up every year. And if you have an adjustable rate mortgage, your monthly payment can rise too.
Your mortgage payment is just part of your housing cost as an owner. You also have to factor in the cost of property taxes and homeowners insurance, both of which have been rising significantly in recent years.
Homeowners saw annual property tax hikes averaging 4-5% (for a total increase of 18%) between 1997 and 2001. And homeowners insurance rose 7% in 2003 and is expected to increase another 8% in 2004. Since 1999, average premiums have skyrocketed 26%. And if you have an adjustable-rate mortgage, your costs will rise if interest rates go up.
MYTH# 5: Investing in a house is a safe investment.
Reality: There are very few risk-free investments and a house is certainly not one of them.
House prices are not a one-way escalator going up. They can also go down. Predicting whether a specific house in a specific market will appreciate is very difficult. As financial columnist Jane Bryant Quinn noted, “any single [house] sale is as much a lottery as trading stock is." If prices do fall even slightly and you have taken out a low or no-down payment mortgage, you could find yourself owing more on your house than it is worth.
Plus, experience suggests that even in a booming housing market, you'd probably earn more on your money in stocks than in real estate. According to the editors of SmartMoney magazine, “compared with the average share prices or even bond returns, house prices plod up at a very slow rate: since 1979, about 4.4% a year.
If you can't do better than that in the stock market, you need to fire your broker." In 2001, Harvard University's Joint Center for Housing Studies found that “in many places at many times, and for many holding periods during the past 15 years, renting made better financial sense than owning."
“In short, this investment [homeownership] is not a slam dunk. For decent returns on any home, you need either stupendous luck or a holding period long enough to amortize your many costs."
Jane Bryant Quinn
“In many places at many times, and for many holding periods during the past 15 years, renting made better financial sense than owning."
Source: National Association of
Realtors; CRSP: Lehman Bros.
MYTH# 6: I can't afford not to buy with these low interest rates.
Reality: Low interest rates may actually serve to make buying more expensive.
It sounds counterintuitive, but low interest rates can actually make housing more expensive, not more affordable. How? Well, if low rates bring a lot of new buyers into the market, housing can turn into a seller's market. Now that there are more prospective buyers competing for the same houses, sellers can demand higher prices.
So, interest rates may be low, but they haven't made housing more affordable if they have also pushed up sales prices. Plus, if interest rates increase, the seller's market could quickly turn into a buyer's market.
If you paid the peak prices commanded during the seller's market, you could find yourself having to sell your house for less than you paid for it if higher rates reduce the number of prospective buyers. The lesson here is that while interest rates matter, you should not feel compelled to buy just because they are low. You may be overpaying for that house just to lock in a low rate.
Don't buy the myths
“I feel safer in an apartment, because other people are around and I like the planned social activities, which are on-site so I don't have to drive."
Elementary School Teacher
MYTH# 7: I know I'll make money on my house because I plan to stay there at least five years.
Reality: Nearly one third of all homeowners move within five years and many end up losing money.
Most people who buy a house plan to stay there for a long time, but many end up moving sooner than planned for job and personal reasons. Short-term homeownership can be a costly proposition. The cost of a round trip into and out of homeownership can be as much as 10% of a house's sale price.
If you move in a few years, those costs could easily exceed whatever equity and appreciation you've realized. In a worst-case scenario, you might have to write a check in order to sell your house.
Or you could find yourself needing to either sell your house at a loss or forego a superior job opportunity elsewhere.
According to one research report, buyers who sold within four years paid, on average, 19% more as owners than they would have paid as renters. If you think there is any chance you may be moving again within the next several years, renting deserves serious consideration.
“I have owned three homes previously and dislike the typical owner headaches, such as mowing the lawn, painting, replacing roofs, etc. I like the sense of family, friendly surroundings and professional atmosphere associated with apartment living."
San Antonio, Texas
MYTH# 8: Buying a house will force me to save and help build a nest egg for retirement.
Reality: This is a risky and unwise investment strategy.
Mortgages can work like a forced savings program. Instead of paying rent, you pay your mortgage and build up equity, assuming you stay long enough to cover the costs of buying, maintaining and then selling the house.
But remember, nearly one third of all owners move within five years, before they start building any real equity. But even if you stay, is this really a wise investment strategy? First, it's risky. It's like putting all your wealth in a single stock. Second, over time, you are likely to earn a better return in the stock market (See Myth# 5).
The editors of SmartMoney magazine came to the same conclusion in a February 2002 article. They wrote, “For most of us, building wealth with our residence is a slow and inefficient process, if it works at all. It's especially hard in this era of low inflation, simply because the underlying asset, your home, typically doesn't appreciate very quickly…The fact is, when it comes to outsized returns, equities win walking away."
“Forget what your friends say. Owning a home is hardly the best way to save for retirement. How do we know? We ran the numbers."
SmartMoney, February 2002
MYTH# 9: I know buying is better for me because I used an online “Rent vs. Buy" calculator.
Reality: Most of these calculators are overly simplified and seriously flawed.
An economic analysis of the leading calculators found numerous problems. Some fail to include basic costs like maintenance, insurance or property taxes. Others leave out the transaction costs of buying and selling a house.
Almost all of them assume you will itemize your tax deductions, when only 34% of all taxpayers actually do. Most do not factor in the returns you could earn by investing your savings instead of using it as a down payment.
The end result is that consumers who rely on these tools may make one of the most important decisions of their lives based on misleading data.
The Bottom Line
RENTING IS EASIER.
Apartments offer maintenance-free, hassle-free living.
RENTING IS MORE FLEXIBLE.
When you rent, you can relocate for job opportunities without incurring the cost of selling a house.
RENTING IS LESS RISKY.
When you rent, instead of tying all your wealth up in a single investment, you can invest in a variety of stocks, bonds and mutual funds. In fact, you can still invest in real estate through Real Estate Investment Trusts (REIT), either individually or in REIT mutual funds.
APARTMENTS OFFER A LIFESTYLE ALTERNATIVE.
Today's apartments offer amenity packages that rival (and often surpass) single-family houses as well as access to new technologies that may be unaffordable in single-family houses.
Apartments often are located in neighborhoods with convenient access to transportation, employment, retail and entertainment.
RENTING OPENS DOORS
Renting allows you to use your “down payment money" for other investments, to start a small business, to travel, or even to change careers.
“We wanted to be free of the responsibility of a homeowner and to be able to invest all of our money in the business. Apartment living is ideal because it is maintenance-free, convenient and worry-free."
Rose and Gary Trousdale
1. “Unwise Wisdom: Buying a house is better than renting." The Wall Street Journal, January 29, 2001.
2. NMHC tabulations of 2003 U.S. Census Bureau/Bureau of Labor Statistics Current Population Survey March Supplement.
3. Magali Rheault, “Tax Time: How America Files." Kiplinger's Personal Finance, April 2004.
4. June Fletcher, “Every House is a Money Pit." The Wall Street Journal, September 4, 1998.
5. Liz Pulliam Weston, “The hidden costs of home ownership." MSN Money Web Site. on April 13, 2004. http://moneycentral.msn.com/content/Banking/Homebuyingguide/P37628.asp
7. Jonathan Cohen, “The American Dream, Revised as a Rental." The New York Times, July 12, 1995.
8. NMHC tabulations of the U.S. Census Bureau's American Housing Survey for 1997 and 2001.
9. Insurance Information Institute. Found at www.iii.org/media/facts/statsbyissue/homeowners/ on April 14, 2004.
10. Jane Bryant Quinn, “Home Prices Bounce Back: But a third of buyers won't hold their property long enough to make money." Newsweek, March 16, 1998.
11. Jersey Gilbert, “Is Your House Really a Good Investment?" SmartMoney, February 2002.
12. The State of the Nation's Housing 2001. Joint Center for Housing Studies of Harvard University, 2001.
14. “Rent vs. Buy Calculators: How Helpful Are They?" Research Notes, National Multi Housing Council, June 29, 2001. www.nmhc.org/Content/ServeContent.cfm?ContentItemID=1159&IssueID=80
15. “The High Cost of Short-Term Homeownership." Research Notes, National Multi Housing Council, December 1, 1997.
16. Jersey Gilbert, “Is Your House Really a Good Investment?" SmartMoney, February 2002.
18. “Rent vs. Buy Calculators: How Helpful Are They?" Research Notes, National Multi Housing Council,
June 29, 2001. www.nmhc.org/Content/ServeContent.cfm?ContentItemID=1159&IssueID=80
Bloggers' turf on Housing bubble http://thehousingbubble2.blogspot.com/
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